(PUB) Investing 2016

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4 • Fund Family Shareholder Association
Now, let’s look back, and then for-
ward. To review, since we bought High-
Yield Corporate at the end of September
2011 through the end of February 2016,
our 30.0% gain nearly tripled Total
Bond Market Index’s 11.2% return.
What’s happening in the high-yield
(or junk bond) market right now is
related to the energy sector more than
anything else. With the U.S. economy
fundamentally sound, there isn’t that
much to be concerned with in terms of
the economy sinking the prospects of
most high-yield borrowers. However,
there is a segment of the high-yield
market that is represented by oil drillers,
and in particular smaller companies in
the fracking business and oil-field ser-
vice sectors, which are undercapitalized.
These riskier borrowers are in trouble as
falling oil prices have made their wells
uneconomical. It’s a given that defaults
among this group of borrowers will be
rising. That’s not a surprise, and it’s
already priced into the market.
We’ve seen a similar cycle in high
yield before. In the late ’90s, the
Internet was going to change the world,
and so money poured into telecom and
tech companies. When the boom came
to an end, a lot of smaller, less-estab-
lished telecom and tech companies that
borrowed money in the good times
weren’t able to pay back their loans.
The overall high-yield bond market
saw prices decline as investors sold
indiscriminately, but the lasting pain
of defaults was largely limited to the
telecom and tech sectors.
This time around, new drilling tech-
nologies and a concerted effort to devel-
op energy independence were going to
change the game. Money poured into
the energy sector, and loans were made
that probably shouldn’t have been or at
a minimum were predicated on energy
prices remaining at elevated levels.
Today, the overall high-yield bond
market is feeling some pressure as
investors shoot first and ask questions
later, but one sector’s woes do not
necessarily spell rolling defaults across
the market—and in this case, lower oil
prices may hurt the oil-service compa-
nies while bolstering other companies
that benefit from lower oil input prices.
At the end of 2015, bonds in the
energy sector represented just 9.1% of
High-Yield Corporate’s portfolio. And
the bulk of the fund’s assets are not
invested in the junkiest portions of the
junk bond market. In the realm of junk
bond funds, Vanguard’s is pretty plain-
vanilla and is not out reaching for the
highest-yielding bonds with the junki-
est credit ratings. But that doesn’t mean
it can’t lose money from time to time.
To give you a sense of periods when
the fund has generated negative total
returns, since the financial crisis, High-
Yield Corporate has only seen a dozen
six-month periods when returns were
negative. January and February mark the
end of the 13th and 14th such six-month
periods. So I understand your concern if
you aren’t taking a longer view.
Though the fund only declined 1.0%
in January and gained 0.1% in February,
it was down more than 2% midway
through both months. While unsettling
to some investors, that’s not actually
all that unusual. Since its December
1978 inception, High-Yield Corporate
has seen 38 monthly declines of 2% or
more. Four of those have been during
our latest holding period.
On the other hand, High-Yield
Corporate has never seen consecutive
calendar-year losses in its history. The
1.4% decline in 2015 was the second-
smallest calendar-year loss the fund
has ever suffered, and only the fifth in
three decades. I recently discussed the
high-yield markets with a very astute
portfolio manager, who made a terrific
point that the math in the high-yield
bond market works particularly well
in investors’ favor so long as they can
think long-term. He made the observa-
tion that as junk bond prices fall and
yields rise, and as the yield on your
junk bond fund rises, it becomes harder
and harder for the fund to actually lose
money in the ensuing 12 months.
Think about it. At the end of 2014,
High-Yield Corporate’s SEC yield was
5.04%. But the fund’s share price fell
6.7% in 2015, one of the largest declines
in the fund’s history. The fund lost 1.4%
(not 1.7%, because yields continued to
rise over the course of the year) on a
total return basis in 2015, as I said.
But at the end of 2015, High-Yield
Corporate’s SEC yield had risen to
6.27% from a low of 3.85% just 18
months earlier. The fund’s price will
have to fall more than 6.3% during
2016, which in itself would be a huge
decline, before it generates a loss on the
year. It’s extremely rare to see back-to-
back price declines of that magnitude.
HIGHYIELD FROM PAGE 1 >
High-Yield Annual Returns
198819911994 1997200020032006 200920122015
-30%
-20%
-10%
0%
10%
20%
30%
40%
High-Yield’s Portfolio Isn’t
the Junkiest
U.S. Gov.
AaaAa1Baa2Baa3Ba1Ba2Ba3B1 B2 B3
Caa1Caa2Caa3
C
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
High Yield’s SEC Yield
1/097/091/107/101/117/111/127/121/137/131/147/141/157/151/16
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%